Investors may just have to live with slightly lower profit margins at Intel as the world's largest chip maker is forced to coexist in the same markets with much-smaller rival Advanced Micro Devices.
Shares of Intel fell as much as 97 cents, or 4.4%, to $21.33 in after-hours trading Tuesday after the Santa Clara-based company said its gross margin for the current year is expected to be around 50%.
Analysts were expecting a slightly richer forecast, sending the shares tumbling. They continued their fall Wednesday.
The shares fell despite signs in the company's fourth-quarter and full-year 2006 financial reports that Intel is selling record numbers of more expensive microprocessors and appears to have emerged from a painful price war with AMD .
"We saw strength in the server market for the second quarter in a row," Intel chief financial officer Andy Bryant told CNBC. "We continue to see strength in the mobile space as the desktop-to-mobile conversion continues. The desktop space was a little bit weaker for us."
Dean McCarron, principal analyst at Mercury Research, said investors should get used to the idea that Intel has to share space with AMD in markets such as server and notebook chips that Intel once had almost exclusively to itself.
"It was a very positive quarter for Intel in the face of some very serious competition," McCarron said. "They seem to have kind of put the hard part behind them. Clearly the market would prefer that they have higher profit margins, but in this environment, that's probably not all that realistic."
Intel managed to beat analysts' tepid expectations for the fourth quarter despite the company's profit plunging 39% and the fact it continued to pay for a massive restructuring and other streamlining efforts.
During the quarter ended Dec. 30, Intel's net income was $1.5 billion, or 26 cents a share, versus $2.45 billion, or 40 cents a share, in the same period a year ago.
Revenue for the quarter was $9.7 billion, down 5% from $10.2 billion a year ago.
Excluding the effects of share-based compensation, Intel said it earned $1.7 billion, or 30 cents a share, beating analyst estimates.
Analysts were expecting the company to earn 25 cents a share on $9.44 billion in revenue for the quarter, according to a survey by Thomson Financial.
"Intel's product and technology leadership yielded a strong fourth quarter with higher selling prices and record unit shipments in the fastest growing segments of the market," the company's chief executive, Paul Otellini, said in a statement.
Intel said its gross margin of 49.6% for the quarter improved slightly over the third quarter on the sale of more expensive microprocessors.
But those gains were partially offset by write-downs in its flash memory division, startup charges for its new NAND flash unit, and factory underutilization charges as the company moves to a more advanced manufacturing process.
A massive restructuring announced in September that called for the elimination of 10,500 positions -- or 10% of the company's work force -- also weighed on earnings.
Intel said restructuring-related charges decreased earnings per share by about 1.5 cents. The company finished the year with 94,100 people, compared with some 102,500 employees the company had in the second quarter before the restructuring was announced. The overhaul is expected to save the company $3 billion per year by 2008.
Some of the company's other streamlining moves are paying off.
Intel said it recorded a net gain of about 2.5 cents a share for the quarter related to the sale of a money-losing division that makes chips for cell phones and other handheld devices. Intel announced in June that it planned to sell the division to Marvell Technology Group for about $600 million.
Mario Morales, vice president of the semiconductor group at research firm IDC, said Intel appears to have stabilized its business after a year of plunging average selling prices for its chips and the loss of market share to AMD. However, Intel will still likely face fierce competition with AMD in the desktop market, he said.
"It's a slow market but still where a bulk of the business comes from," Morales said. "That's where you're going to see a lot of the battle."
For the year, Intel said revenues were $35.4 billion, and it earned $5 billion, or 86 cents a share.
Intel said it expected revenue for the first quarter of 2007 to be between $8.7 billion and $9.3 billion, and that gross margin for the full year is expected to be about 50%, plus or minus a few percentage points.
Doug Freedman, an analyst with American Technology Research, said Intel appeared to be regaining its footing in the battle for market share with AMD, but that the gross margin forecast came in lower than expected and was likely causing the company's stock price to drop.
"It's a question of, 'Are the price wars over?"' Freedman said. "Or is this a sign that Intel is cautiously optimistic about pricing? I think they're wise to be cautious. Given that this is the first quarter in a while that the company has actually beat (estimates), that's a smart avenue to take."
The year has been a tough one for Intel in attempting to halt AMD's encroachment on turf Intel once claimed almost exclusively as its own.
Through the third quarter -- the latest period for which data is available -- AMD had gained about 5.6% in market share over last year, with much of those gains coming at Intel's expense, according to Mercury Research.
And price competition weighed heavily on both companies all year.
The average selling prices for Intel's processors fell by about 15.5% over last year, according to Mercury Research. Meanwhile, AMD has reduced its prices by only about 2.2% and has warned investors that operating income for the fourth quarter is expected to be "substantially" lower than the previous period because of the pricing pressures.